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StockTalk

TMF Interview With
Critical Path President & CEO Doug Hickey


With Dave Marino-Nachison (TMF Braden)
September 14, 1999

San Franciso-based Critical Path (Nasdaq: CPTH) provides business-to-business Internet messaging to corporations, Internet service providers, Web hosting companies, and Web portals.

TMF: First, I guess the best thing to do would be to ask you to give us an overview of what Critical Path does and where you guys are trying to go.

Hickey: I guess the target of what we do is really focused on providing outsourced e-mail and messaging solutions to four distinct categories. Those categories being the ISP market, Web hosting, portals and enterprise. To date, we've been able to secure contracts with such notable customers as ICQ, Compuserve, US West (NYSE: USW), MCI WorldCom (Nasdaq: WCOM), E*Trade (Nasdaq: EGRP) and others.

TMF: Looking over some of your filings it seems like a lot of your revenue is tied up in a few large subscribers.

Hickey: That was really in '98. E*Trade and others had a significant revenue piece of the company from a percentage perspective, but when you look at the revenue of Critical Path as it has grown quarter-to-quarter what you see is in Q1 [of this year] we did about a million dollars; that grew to $2 million in Q2. Analysts' estimates have us at about $3.6 million for Q3 so you can see we're almost doubling revenue quarter-to-quarter.

We've also increased analysts' estimates, or guidance to the Street, from when we did our first financing. About $9.9 million was the guidance we gave to the Street. We've upgraded that to about $13.5 million for '99 and up from $40 million in 2000 to $53 million.

TMF: Where is that growth coming from? What portion of your customer base?

Hickey: Well, it's really coming across all customers. What you're really seeing is tremendous amount of traction, with really key brands in each of the categories that I talked about, so we're seeing great adoption rates and now rollout rates with all of our customers. And we're seeing almost a doubling per quarter in the number of sales contracts we sign.

TMF: I would think a lot of your incremental growth is going to come from smaller customers that don't generate quite as large contracts as some of the other ones. Is that why your revenue per mailbox number has been sliding of late?

Hickey: I would take exception to the slide. When you look at the model that was put together it showed in Q2, for example, that the revenue expectation per mailbox was $0.24. We actually hit $0.26. And we exceeded the mailbox count. We did in excess of 4 million mailboxes in the quarter, which was not supposed to happen until Q3 in the original model. And in the original model that would have given us $0.19 per mailbox and we actually achieved $0.26 per mailbox on 4 million. So what we're seeing is what we would contend is high-quality revenue per mailbox that's highly scalable.

"We're seeing almost a doubling per quarter in the number of sales contracts we sign."
The other dynamic that you're seeing is aggressive reduction in the cost structure. I think one of the keys that we really bring is near-term gross margin, leading in Q3 of '99 and ultimately profitability starting in Q3 of '2000 -- and full-quarter profitability in Q4 2000. I don't think you're seeing those kinds of models or aggressive both top line and bottom line recognition in many Internet stories today.

TMF: Do you expect the growth in general will come primarily through customer acquisition or will that be through higher-margin services?

Hickey: Well, I think you hit on a key point. The model today is really through organic customer acquisitions and looking at customers like ICQ and StarMedia (Nasdaq: STRM) and our enterprise customers who are growing pretty dramatically, not just from number of users but in revenue per user. The second piece is we're firmly convinced that a key difference here going forward will be the ability to add value services on top of those existing platforms. And those services really come at almost 100% margin for Critical Path as we're able to deploy those services across the same physical platform.

TMF: Are you developing those technologies in-house, the sort of things where you'll be adding extra services? How do you come about those new products?

Hickey: What we've done is gone through a strategic build-buy analysis to determine whether or not it makes sense to go to the market and acquire technologies or build internally. And to date we've done both. I think you've seen that we've successfully completed three technology acquisitions here in the short term, two of which are focused on enterprise-type offerings and the third, a company [called] Amplitude that we acquired in San Francisco just recently that is really [focused] on calendaring and synchronization technologies. So where it makes sense we'll build it internally. Where it makes sense we'll also go out and purchase those technologies.

TMF: Can you talk about who you consider your direct competitors right now?

Hickey: Well you know, I think that the market has said there's really three distinct models out there. One is a model of retail users or retail end-users -- companies like Mail.com (Nasdaq: MAIL) and CommTouch (Nasdaq: CTCH) and USA.net really fit in that category where they derive the revenue from CPMs.

TMF: Will you define that?

Hickey: Yeah. What happens is in that kind of model, you'll hear those types of companies report a whole series of free mailboxes on a quarterly basis -- in many cases 10 million mailboxes.

"We're firmly convinced that a key difference here going forward will be the ability to add value services on top of those existing platforms."
But what they really monetize is probably 10% to 15% of those mailboxes as active, then they go sell advertising as part of that. We do not do that. But some people have viewed that as competition.

Then you look at companies in the insourcing space that really provide software licensing models to customers and you see those companies like Sendmail and Software.com (Nasdaq: SWCM) and a number of others within that space and you're seeing them grow at probably 8% to 9% per quarter and their revenue is primarily 60% derived from software licenses, 40% from professional services.

If you look at Critical Path, ours is a monthly recurring model so every mailbox we report has revenue associated with it and it's highly predictable and really develops a couple of key differences. One is we're able to scale growth and if you look at the '99 numbers -- you see profitability associated with what we're doing in 2000 -- I think that speaks volumes to the credibility of the model and the way we do things. So all of our customers are multi-year customers, monthly recurring and highly scalable.

TMF: It sounds like then what you're saying in terms of acquisitions it would be more reasonable to expect Critical Path to do them for technologies than for customer buys?

Hickey: Yeah. I think that's absolutely true. Now, in the event that there's some interesting customers in that mix that's obviously attractive [they might buy a company for its customers], but we think that going forward the customer that we sell to will be looking for a total envelope of services of which e-mail is a portion and, really, the delivery mechanism, and then we'll lay on top of that other value-added services.

TMF: Having just talked a little bit about some of the differences between the models of your company and some of the others, what would you consider the metrics investors should really be following to measure your progress relative to your model?

Hickey: I think that's a great question because I think there's some confusion out there quite frankly. What we suggest that people really look at is, number one, to look at quarter-to-quarter revenue growth to make sure that we see aggressive growth in the top line.

Secondly is to look at revenue per mailbox because that will indicate the kind of mix that we're seeing in the market. The third is to see cost-per-mailbox, and I'd like to come back to that in a minute. And the fourth would be net new mailboxes served, if you will, quarter to quarter. I think in that envelope is the way investors ought to measure not just Critical Path, but other people within the space.

And on the cost per mailboxes, for Q1 that was about $0.51 per mailbox per month. In Q2 that dropped to $0.41. In Q3 we expect, or analysts expect, mid 20%. So you can see we are driving down the cost element very, very aggressively and one of the keys is since we're able to serve these different platforms across the same technical platform within Critical Path we can drive down the cost very aggressively.

TMF: Can you talk a little bit about first of all your customer service operations and also about your promotions and marketing?

Hickey: We're really the brand behind the brand. So we're not the brand that touches customer service from the end-user perspective. We customer service, if you will, ICQ, Star Media, those types of folks, as opposed to the end user. I think that's a significant advantage.

Relative to marketing, we have a relatively small sales force. You'll never see us have a huge direct selling force. So virtually every one of our customers is a distribution force for us. I think it's very notable when you look at customers like Sprint (NYSE: FON) and MCI Worldcom, Qwest (Nasdaq: QWEST) recently just signed with us, StarMedia, ICQ and others. It's really the feet on the street, or the brand, that actually pushes our product.

TMF: Sort of a timely question. I guess it sounds like you've been on something of a road show these past few days. I was wondering if you could talk about where you've been, what you've been doing and what people have been asking you.

Is there one sort of package that's the most common set of services that's being purchased by the average customer?

Hickey: I think if you look at the average customer, what they're buying is the ability to scale limitlessly, especially in the Internet-centric market. I think the other thing they are very concerned about is spam control and virus control because if you're serving up mail on a traditional server it's very difficult to control spam at your server -- it's almost too late. So what we're able to do by virtually being at the network level we can recognize spam as really blasted mail before it gets to the sight so customers are very interested in that.

I think third is the ability to integrate other services going forward. You can envision companies like the large portals that we're doing business with understand that they need to continually add services in order to attract and retain their base so that's a key, key aspect. E-mail is really a platform by which we deliver all of these other services and that clearly is gaining significant traction.

TMF: It sounds like one of the keys to your business is to give people the reason not to switch at a certain point by showing them there are upgrades coming and there are reasons that they would want to keep using your service and adding to it.

Hickey: Yeah. I think that that's absolutely the case and what happens is since it's not a basic service, it's a value-add service to which we continually have created implementations. That makes the relationship with our customers more and more intimate or more sticky, if you will. The other part of it is we sign multiple year contracts with our customers, none are less than one year. Some of our larger customers have signed actually four-year contracts with us so that gives us again great predictability into revenue that we have coming from the future.

TMF: Now is probably a pretty good time to wrap this up, but is there anything else that you'd like to ad?

Hickey: I'm going to tell you that we're real excited about where we are. We see tremendous revenue growth. We know we're on target to reach profitability with the company. We're accelerating in virtually every category. And one surprise, quite frankly, has been the adoption internationally of services that Critical Path offers and we've gained quick traction there with some very notable brands virtually across the world, and I think one of the key reasons there has been our ability to localize in 16-plus languages to date and allowing our customers the ability to brand their service to be sensitive to not just language differences but cultural differences.

TMF: Since you brought it up, which foreign markets have you been having the most success in?

Hickey: Asia's been incredible in the short term. We just signed a deal with Mitsui in Japan and that relationship is to attack the digital phone market in Japan and so now you'll see, starting in the fourth quarter, the ability to integrate e-mail across the digital screens that exist within the wireless arena in Japan. That's about a 7 to 9 million user opportunity for us there.

We also signed Asiamail.com, we signed Sina.com, StarMedia ... [and] the largest site in India... We signed British Telecom as a customer, Avantel in Mexico, which is the second-largest telephone company in Mexico... and a number of other services, so we've really seen really tremendous traction there.

TMF: How big a portion of your revenues do you see in international business becoming?

Hickey: Well, I've always viewed that international will be 20% to 30% of our business in 2000 and I clearly feel that we're on track for that.

TMF: Well, this has really actually been quite a good interview and I appreciate your taking some time out of your day to help us out here.

Hickey: Well, I appreciate your time.

TMF: Thank you sir. You have a good day.

Hickey: You, too.

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